Build Up Your War Chest
There goes half of August’s revenue.
This was the thought I had when the Doctor told me my son had hand, foot, and mouth disease.
Of course it happened during the one week I set aside to get billable work done.
(Recall that I’m only billing two days a week now so it’s a pretty big deal!)
Instead of earning $6k for the week I spent it comforting my son.
Everything he ate hurt. By the second day he was on a smoothie and milkshake diet.
What. A. Life.
It sucks, but as Freelancers we have to learn to deal with variable income.
A ton of things can disrupt our cash flow:
- A late payment
- Not billing due to being sick or a family emergency
- Having a hard time finding the next client
- Taking an immediate vacation because you’re burned out
- An unexpected bill from the IRS
- Deciding to take the day off because it’s the one day of the Summer that Virginia Beach actually has waves
And these things make dealing with money stressful because everything feels like it’s unpredictable and out of control.
So what is the point of taking the giant leap of becoming your own boss only to be ruled by your business?
30-Foot Runway VS a 3-Mile One
Take a deep breath…
There IS a way to build a business that prepares for flukes and fluctuations and gives you freedom to change plans.
Let’s switch metaphors – if your business was an airplane, would you, the pilot, be more stressed about taking off from a 30-foot runway or a 3-mile runway?
How we handle our money provides the runway that lets us keep rolling even if momentum slows once in awhile on the way to a smooth flight.
Or when our co-pilot can only drink smoothies for two days.
Taking control of our finances is the key to lengthening that runway and smoothing out the ride.
So let’s do it.
Get a Business Account
The first piece of low hanging fruit, if you haven’t already done this, is to get a separate business account. Your business and your personal finances might be linked in ways that feel a little blurred when your taxes are due but they are separate.
Ryan? I have a few questions.
Should my business account be at the same bank as my personal account?
That depends on your bank and your own preferences.
There are advantages to doing all your banking in one location – lower fees, simplified fund transfers, more predictable expenses – but different banks offer different incentives for business accounts. Ask around.
Should I get a business credit card?
A business credit card is one way to build a credit score for your business, and some people find it simpler to track or manage business expenses through a credit card.
I run on the principal that you should only pay expenses with a credit card that you can cover with cash. Otherwise, you just have a new form of anxiety to add the the financial picture of your business.
A lot of people have complained about having a hard time getting one when starting out. Personally, I got the American Express Simply Cash Business Card within my first month of business with no issues.
Do I need a business name for my new account?
What’s your business structure?
As a sole proprietor, your name is your business. But if you’re an LLC or an S-corp (both of which I generally recommend for freelancers in this industry), then the business name goes on your business account.
Anything other questions? Feel free to let me know.
I think I’m good for now.
Build that War Chest
Okay. After you’ve got your business bank account, building a war chest should be your primary goal. That means savings.
Savings are the first line of defense against your lizard brain.
LIZARD BRAIN: Who cares if this client won’t pay your rate, agree to your payment terms, or has a business plan based on advertisements for cats. You haven’t had any work in weeks!
ME (in my early years as a freelancer): Well, cats aren’t all bad…
ME (sitting on six months of runway): I’ll pass for meow. I can find a better client.
That war chest give you freedom to choose your best clients.
Ryan? I have a few questions.
No worries. I’m happy to help.
How long should my runway to be?
If you haven’t had a income gap of more than two weeks over the past two years, two weeks’ expenses might be enough.
More conservatively, if you regularly have a seasonal slowdown of a month or more (or just want a regular vacation), three months worth of expenses might be more realistic.
Remember, anxiety drives the feast or famine cycle. During famines you’re worried about finding the next client. During feasts you’re taking on too much fearing a famine is on the horizon.
The goal is to be far enough ahead of your billing to give you the freedom to work on and experiment with your business.
How long should it take to get there?
If your target is a one month buffer you could easily get there in 6 months if you’re setting aside 50% of client payments. We’ll get into the math next.
But if 50% sounds way out of reach that’s a good sign you should start raising your rates.
Okay, I’m in! Where do I start?
Let’s begin looking at budgeting.
A Plan for Your Income
When first starting out 50% of every client check should go to your business’s checking account and the other 50% should go to the business’s savings account.
The checking account covers month to month expenses: owner’s draw, administrative fees, software costs, and equipment, while the savings account covers quarterly taxes and be set aside for business experiments.
If you earn between $90k and $190k, 28% of that income would go to federal taxes and 6% to state taxes (at least for Virginia).
This leaves 16% for business savings. Or at the end of the year you’d have about 16% of your revenue in savings. Or about two months of buffer (16% * 12 = 1.92).
Another way of looking at this is that it would take 6 months to create one month of buffer. But the reality is much shorter. Deductions add up, especially if you’re being good about separating business and personal transactions.
Yet another reason to create a separate business account!
Now it’s all well and good to predict you’re going to have $190k in billing, but working with percentages means you don’t spend what you haven’t earned. It also means you’re always trying to build that buffer for the lean months.
Ryan, I have a few question…
Seriously?! Don’t you know I have an infant to take care of!
Do you still use this arrangement?
That system worked pretty well for the first couple years of business but budgeting has flipped it all on it’s head. Once you start budgeting you don’t have to make a distinction between savings, checking or credit. You just give every dollar a job.
Using YNAB for Budgeting
Using a budget system like YNAB (You Need a Budget) you’re able to answer the following questions:
- If I stopped earning money today how many more months would I be able to pay my salary and our family’s health insurance?
- I want to buy OmniFocus 2 and it costs $39.99, which monthly bucket should I pull money out of to cover the unexpected expenses?
- I pay $2,600 in quarterly taxes how much have I budgeted and how much more a month do I have to save?
Here’s a quick look at my business budget.
Let’s go through this step by step:
At the top under Immediate Obligations there are things that must be paid every month: Salary, Health Insurance, and Internet.
Going down the list, items become less of a priority: they are monthly, quarterly, annual, or even optional expenses.
For instance, right now retirement contributions are a “nice to have” while taxes and accounting must be paid on a quarterly and annual basis.
Remember that my current priorities are being Daddy Daycare 3 days a week, and working billable hours 2 days a week. With some dawn patrol surfing snuck in.
If a tax bill is higher than expected than the money can be moved from 401k Contributions to one of the tax buckets.
If you have any extra money that hasn’t been budgeted you can set it aside for the future.
Because sick kids are a real thing.
Starting Your Own Budget
“Ryan! That looks way more complicated than the pie chart.”
It can be overwhelming. That’s why I’ve used my budget to prepare a template for you so you can start crunching some numbers and start flexing your budget muscles.
Here are the characteristics of the template:
- Payroll for a $53,600 income. The rest of the pay comes from owner’s draw. I use Gusto to manage all of this for me. If this all sounds like gibberish to you talk to an accountant. Or at the very least start paying yourself the same amount every month.
- Health insurance costs $1,040.56 a month for a family of five. We’re on a high deductible plan.
- Retirement isn’t a necessity right now.
- Taxes are payed through payroll but you also pay quarterly estimates.
- Accounting is delegated to a third party.
- Expenses are divided into categories. Like my YNAB budget there the categories for expenses are used to move money from nice to have expenses up to more immediate obligations.
It’s designed to help you set targets, meet them, and move money around as necessary.
Get Started with this Budget Template
Once you get the sheet here are the starting steps:
- Enter in your starting balance. It’s ok if you don’t have money to start out with. You can zero out all the targets and start budgeting for them as you bring in income. Remember every dollar needs a job.
- Adjust the targets in the “Immediate Obligations” section. These are your non-negotiables and must be paid every month. If you don’t have payroll yet make sure you’re paying yourself the same amount every month.
- Don’t worry so much about adjusting the other sections. You’re just exercising your budget muscle this first month. It’s more about exploring than anything else.
- Fill in expenses and income under the Transactions tab as you go along in a month.
- When you find yourself overspending in a category, don’t worry just move the money from another expense bucket.
Keep in mind that every situation is different so this template should not serve as your final solution. You should figure out your own numbers with an accountant. The important thing is to get started.
It’s crazy how much anxiety goes away once you start building a war chest and getting an idea where your money goes.
Aside from the obvious benefit of a backup plan, savings also gives you the financial freedom to experiment with your business:
- Double your rate.
- Say no to risky clients.
- Create a productized offering.
- Write a book.
- Work abroad.
- Focus on positioning.
- Take a sabbatical.
You’ll be amazed at how you start dreaming the different places your business can go as this all takes shape.
As always don’t hesitate to let me know if you have any questions.
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